Traditional stock loan transactions are typically carried out for a number of reasons, including tax purposes, hedge purposes, and “short” sale purposes. A “short” sale is the sale of a security which is not owned by the seller with the expectation that the seller will buy the security at a later date to “close out” the short position (as opposed to a simple sale of a security owned by a seller having a “long” position in the security). A short sale generates short exposure to the party making the short sale.
FIG. 1 shows a cash flow diagram of such a traditional stock loan transaction. As seen in this FIG. 1, a Lender 101 loans one or more Securities 103 to a Borrower 105 (such as a broker) and receives Collateral 107 in return. In addition, the Lender 101 pays to the Borrower 105 a Rebate 109 (i.e., a predetermined amount which may be paid periodically and which may be a percentage of the value of the Collateral 107), and the Borrower 105 pays to the Lender 101 an In-Lieu-Of Dividend 111 (i.e., a manufactured amount calculated to substantially mirror any dividends paid on the Securities 103 lent to the Borrower 105 during the term of the loan). Further, the loan has associated therewith a Mark-To-Market Payment 113 (i.e. “marking a security to market” and then making a payment from the first party to the second party or from the second party to the first party, depending upon the price of the security at the time the security is “marked-to-market”). The Mark-To-Market Payment 113 is made periodically (traditionally daily) and is based on the current price of the underlying Securities 103. The purpose of the Mark-To-Market Payment 113 is to obtain a collateral payment between the Borrower 105 and the Lender 101. Thus, the Mark-To-Market Payment 113 may be made from the Lender 101 to the Borrower 105 or from the Borrower 105 to the Lender 101, depending upon the price of the Securities 103 at the time the periodic Mark-To-Market operation is carried out. Specifically, the Mark-to-Market Payment is paid according to the following calculation: at the first point in time (“t”), the Mark-To-Market Payment is equal to: (1) the value of the security at the point in time the security was lent minus (2) the current value of the security at time t. At the next point in time (t+1), the Mark-To-Market Payment is equal to: (1) the value of the security at time t+1 minus (2) the value of the security at time t. A similar calculation continues for each periodic Mark-To-Market Payment.
In a related type of traditional transaction, such as shown in FIGS. 2A-2C, short synthetic exposure is shown. Short synthetic exposure means exposure that reflects an equivalence to the financial exposure generated by a short sale and typically employs derivatives. Short sales are typically used in trading strategies where investors seek to generate positive returns when securities are dropping in value. There are four general types of trading strategies: (1) arbitrage; (2) hedging; (3) directional short selling; and (4) financing. Further, there may be other more complex strategies that incorporate elements of the basic strategies (e.g., tax trades, complex derivative trades, etc). More particularly, as seen in FIG. 2A, if a Broker 201 maintained a long position in a desired security, such as Stock 203, the Broker 201 (via a trader) could enter into the long side of a short synthetic exposure transaction (via TRR Swap 205) with the Hedge Fund 207 and sell the appropriate number of shares of Stock 203.
On the other hand, if the Broker 201 did not have the required underlying position, then generating the short synthetic exposure generally involved two steps. As seen in FIG. 2B, the Broker 201 (via the trader) would first buy the Stock 203 from an Investor 209 and enter into the short side of the synthetic with the same Investor 209 (via Total Rate of Return Swap “TRR Swap” 211). In step two, seen in FIG. 2C, the Broker 201 (via the trader) would then enter into the long side of a synthetic with the Hedge Fund 207 (via TRR Swap 205) and also sell the appropriate number of shares of Stock 203 (similar to selling from a long “proprietary” position).
The above described “short synthetic exposure” type of traditional transaction suffers many of the following disadvantages:    1) There may be multiple levels of purchases and sales, generating transactions taxes, stamp taxes and broker fees and commissions.    2) The transaction may expose the broker to foreign exchange risk. For example, if currency controls were implemented, it is possible that the broker could not repatriate the cash proceeds of the sale, or generate local currency to “buy-to-hedge” or to “unwind” (e.g., reverse) the transaction. “Buy-to-hedge” refers to the purchase of an asset (e.g., property or a security (including a stock or a derivative, for example)) to hedge an exposure in the opposite direction. Further, the transaction may involve underlying stock or it may involve a derivative or other instrument. For example, a trader may have short exposure in a convertible bond that converts into stock. The trader may elect to “buy-to-hedge” the underlying stock of the convertible, in a ratio that correlates with the conversion ratio of the convertible bond.    3) Issues similar to 2 above might arise if the broker were prevented from trading for some reason.    4) The transaction may impact the broker's balance sheet (when the broker acquires the securities the broker is essentially entering into a hedge).    5) The transaction may have significant reg-cap and cash-cap impact (i.e., the transactions may require the broker to use either regulatory capital (i.e., a minimum amount of capital which is required to be maintained to trade on a certain exchange) and/or cash).    6) Unless the transaction is “reset” (by adjusting the swap price after the initial sale by the investor, for example), mark-to-market exposures may arise. For example, if counterparty A was long the synthetic exposure and counterparty B was short the synthetic exposure, if the assets(s) represented by the transaction went up in price, counterparty A would have the risk since counterparty B would have an obligation to pay counterparty A at some point in the future. If the assets(s) went down in price, the opposite would be true.
Among those benefits and improvements that have been disclosed, other objects and advantages of this invention will become apparent from the following description taken in conjunction with the accompanying figures. The figures constitute a part of this specification and include an illustrative embodiment of the present invention and illustrate various objects and features thereof.